SEP IRA
My self-employed client has still yet to file his 2007 taxes and is interested in opening and funding a SEP IRA for 2007. His reported income before taxes is about $60,000, however his AGI after expenses is about $30,000.
I know that the SEP Maximum contribution for 2007 was $45,000 or 25% of compensation (whichever is less). However, is compensation considered that year’s AGI or the Income before expenses?
So, given this scenario, would his maximum contribution be $15,000 or $7,500 for 2007?
Permalink Submitted by Denise Appleby on Tue, 2008-07-08 23:48
By self-employed, you mean sole-proprietor (unincorporated) right? Just checking.
For an unincorporated business owner, contributions are based on modified net profit, which is net profit less ½ S/E taxes. The maximum contribution is 20% of modified net profit -NTE $45,000.
For a more detailed explanation, I am including Bruce Steiner’s response to a similar question… as it explains why it is 20% and not 25%
[quote=”bsteiner”]The 20%/25% concept is intended to put self-employed in the same position as employees. For example (ignoring social security and Medicare taxes), if your business is in the form of a corporation, and you earn $100,000, the corporation can use the $100,000 to pay you a salary of $80,000 and to contribute 25% of your salary, or $20,000, to a retirement plan.
If you’re self-employed, you (not your business) is making the contribution to the retirement plan. To put you in the same position as if you were operating in corporate form, your contribution is 25% of your earnings net of the contribution (25% of $80,000, or $20,000), which is the same as 20% of your earnings before the contribution (20% of $100,000, or $20,000).
There are also some adjustments made with respect to social security and Medicare taxes, again to put you in the same position as if you were operating in corporate form.
The advantage of being self-employed is that if you retain some of your earnings in the business, this amount will count as self-employment income, but will not count as salary if you are using the corporate form. Of course, there are other factors to consider in the choice of entity, and one should consult with counsel in determining the choice of entity.[/quote]